An equity-to-value ratio is an excellent tool for those homebuyers that want to understand how profitable an investment is based on the amount of money invested and the actual value of the property. Real estate investors often use it but it is also a tool house flippers can use in order to figure out the potential profit they can make on a property.
The equity-to-value ratio is the percentage of the purchasing price of the property when compared to its total appraised value. If a property is appraised at $400,000 and the price paid is $300,000, the ratio is 75%.
The equity-to-value ratio is opposite, in ways, to the loan-to-value ratio. The equity-to-value ratio is used to find out the value invested in the property by the homebuyer and the profit it brought them, however, and the loan-to-value ratio is used by lenders to determine the risk of lending money to the homebuyer. The best way to differentiate the two is to know what they are used for. The loan-to-value ratio is used when a homebuyer wants to take out a loan to purchase a property and the equity-to-value ratio is used when the homebuyer wants to know how much they invested in the property before or after a loan was taken out. Another thing that sets the two apart is that the loan-to-value ratio goes down with every payment while the equity-to-value ratio goes up.
To put it simply, the equity-to-value ratio is the homebuyer’s actual investment in the property. In order to explain this fully, we’ll give two examples. In the first one, there will be no mortgage included, while in the second, we’ll include a mortgage to spice things up.
Calculating equity-to-value ratio without a mortgage:
A real estate investor or a house flipper sees a house that was recently foreclosed on because of a default on a mortgage. Because the seller requires money as soon as possible, they sell the house for $100,000 even though its appraisal price is $200,000. The investor or house flipper takes the opportunity and buys the property for $100,000. That is their equity, the amount invested in the property. This means that while the buyer only invested $100,000 in the property, their equity, the equity-to-value ratio is 100%.
Calculating equity-to-value ratio with a mortgage:
A homebuyer wants to purchase a property evaluated at $300,000. They only have $100,000 for their down payment. For the remaining value of the property, the homebuyer takes out a mortgage. At the time when they purchased the house, their equity was $100,000 which makes their equity-to-value ratio at 33%. As months and years pass, the homebuyer makes payments toward their mortgage. With each monthly payment, their equity increases, and so does their equity-to-value ratio.
Equity-to-value ratio = equity (actual investment of the buyer) / appraised value of the property